Deficit Commissions Extreme Proposals Spell Disaster

The draft proposal released as a surprise yesterday by the two chairmen of President Obama’s fiscal commission is conceived and written in panic. It is a profoundly ideological set of policy prescriptions. The co-authors are counting on national alarm over the current budget deficit to make extreme proposals seem reasonable. It is an outrageous, misleading document, unsupported by evidence.

The current deficit of $1.5 trillion is no reason for alarm. It is the result of the recession, which created large reductions in tax revenues, as well as increases in automatic stabilizers like unemployment insurance. The Obama stimulus of $800 billion also is part of the deficit. But as a modeled by economists Alan Blinder and Mark Zandi, the deficit would have been higher without the stimulus.

The longer term deficit is also too often attributed to “big government.” The projection of the Congressional Budget Office, adjusted for some realistic policy changes, such as the extension of the Bush tax cuts, is that the deficit will actually fall substantially to 4 percent of GDP and stay there for some time. Debt rises to 77 percent of GDP.

This increase is hardly trivial and a 4 percent deficit may not be sustainable. But increases are not the result of rising outlays for Social Security, Medicare or Medicaid, contrary to what many, including members of the media, seem to think. The higher deficit and debt levels are overwhelmingly the result of three factors: recession, war spending, and the Bush tax cuts of the early 2000s.

In the 2020s and 2030s, Medicare and Medicaid outlays will at last begin to rise rapidly because overall healthcare costs without serious reform will likely rise rapidly-by 2 percentage points a year more than GDP per capita. This compounds to high levels quickly. Social Security, however, adds rather little to this deficit, rising from roughly 5 percent of GDP to 6 percent over the years. Medicare and Medicaid rise from 5 percent to 13 percent of GDP and higher. Along with interest, the debt can mount to 200 and 300 percent of GDP. Healthcare costs are what America must deal with.

But the White House commission draft proposal goes far beyond focusing on healthcare. First, it wants to reduce radically the income tax rate on Americans. One option is to reduce the top rate of 35 percent to 23 percent, or at the least to 28 percent. This is simply right wing ideology at work, and has nothing to do with deficit issues. To the contrary, the authors are using deficit alarms to present a new tax agenda. Is Obama really going to stand behind it? There is no commonly accepted evidence that current marginal tax rates, or even higher ones, suppress economic growth.

Second, the proposal will also reduce to and maintain federal outlays at 21 percent of GDP. The CBO expects them to be about 24 percent. Why the reduction? There is no reason at all to do so, except an ideological one: less government is always better. Again, there is no absolutely commonly accepted evidence that higher levels of government suppress growth. Yet the proposal is willing to make painful cuts in programs to meet this spurious goal. And it will leave no room for more public investment.

Third, the proposal’s goal is to reduce debt levels to 60 percent of GDP and eventually 40 percent. To do so requires a deficit on average of 2.2 percent of GDP. Again, there is no evidence that debt levels of 60 percent are better than levels of 70 percent, for example. Reducing the debt levels to 40 percent is simply Draconian. One argument is to keep them low to be able to respond to emergencies, as the nation just did. It would be far better to devote attention to avoiding the extreme emergencies.

In fact, American can easily live with a debt-to-GDP level of 70 percent and a long-term average budget deficit of 3 percent. With that as a framework, sensible compromises on spending cuts and tax increase can be reached.

But most dangerous part of this toxic package is that it urges cutting federal spending substantially in fiscal year 2012. At best, the unemployment rate will be in the range of 7.5 percent at that time, which many will fairly still consider recessionary. That is not time to administer austerity. A far better tool, if one had to be deficit minded, is to start reigning in spending or raising taxes (my preference) when unemployment is around 6 percent. I’d wait until it is well down into the 5s. That may take more time.

This proposal is not likely to carry the day. But the surprise publication is a calculated political gesture to win support. And it may surprise the doubters. There are in fact some good ideas in it. The mortgage deduction would be reduced. It calls for a higher gasoline tax. The cap on Social Security taxes would be raised. Large cuts in military spending are proposed.

But these are made palatable only by painful cuts in social programs, far lower taxes on income and corporate profits, aggressive pruning of federal employees, and no talk at all of more investment in infrastructure, education or energy technologies.

In fact, the priority now is to get the economy moving again with a stimulus. Once that is accomplished, the nation must turn its attention to reforming healthcare, and raising tax revenues to support the public investment that will truly prove a foundation for future prosperity.

The current White House proposal is not merely preposterous, it will be a disaster economically if anything remotely like it is passed. It is a nation running backward in defeat, not looking forward to the challenges of a new century and rising competition around the world.